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Latin American renewables:
Energy rich, cash poor

Latin America is a fertile region for renewable energy development but government support is sadly lacking. A report from Rio de Janeiro on how banks are getting involved in project investment.

Latin Americas abundance of natural resources, which are already successfully harnessed in numerous hydro projects, and its scope for producing smart biofuels make the region ripe for investment in renewable fuels. Spending is expanding fast in the region. Hindrances to yet faster growth include unrealistically low tariffs on energy consumption, an uncertain and volatile investment climate and weak access to good-value, long-term financing.

The high cost of fossil fuels  both in terms of price as petroleum hovers at about $120, and in terms of environmental damage  is pulling a new breed of global investor into renewable energy. But there is a long way to go: renewables represented a meagre 1.5% of installed capacity worldwide in 2004.

Slow start

Investment in Latin America has been particularly slow although the pace is now picking up. Most of the interest is concentrated in hydropower and more recently biofuels, say participants at the Renewable Energy Finance Forum Latin America, a conference organised by Euromoney Energy Events and held in Rio de Janeiro in April. The trend now is to build small, localised hydro plants and push on with the roll out of newer technologies, such as wind, solar and to a lesser extent geothermal. Meanwhile, the importance of biofuels continues to grow, particularly in Brazil.

The region represents a minimum of 7% of global project investments in energy through to 2030, with Brazil accounting for almost one-third of that, notes Hugo Altomonte, senior economist and chief of the natural resources and energy unit at the United Nations Economic Commission for Latin America and the Caribbean. Nathaniel Jackson, at the Inter-American -Development Bank (IDB), estimates that the electricity sector in Latin America will require $1380bn in investments to 2030 to meet demand.

So far, the regions energy matrix remains heavily dependent on fossil fuels and hydro plants. The latter are unreliable because of seasonal fluc¬tuations and may also be adversely affected by long-term weather changes, says Mr Jackson. The other weakness that most Latin American systems face is a lack of investment, although Chile is a notable exception. Energy projects have made up only about 20% of foreign direct investments in the past 20 years, leading to unreliable service, and even failures in distribution and transmission.

Such shortages are difficult to resolve due to erratic and often investor-hostile regulation. In extreme cases, Latin American countries covertly sanction energy theft, says Mr Jackson. The Dominican Republic, for example, effectively does not make it illegal to steal electricity, an issue that the IDB wants to help it address to encourage investment. Also, Latin American consumer tariff structures are often too low to attract investors.

Renewables targets

Regional moves have been made to commit countries to renewable energy targets but the mechanisms are weak. Under the Brasilia Platform on Renewable Energies, which was formally agreed by 21 countries in the region, in 2003, signatories agreed to a target of 10% of energy to be generated from renewable energy. Crucially, however, a whopping get-out was included in the caveat that countries would seek to meet the target on the basis of voluntary efforts and taking into account the diversity of national situations.

Another key difficulty in stimulating interest in renewable energy has been reluctance by Latin American governments to provide subsidies. With 15% of the regions population still without any access to electricity, regional governments spending priorities are understandably more oriented towards extending the reach of networks, says Mr Altomonte.

That particularly hurts new gen¬eration technologies, which require government subsidies to make them competitive. For example, Germany has developed the worlds most successful solar power scheme but only due to generous hand-outs (0.42 per kilowatt hour). In sunnier tropical climates, solar energy would be a more efficient way to generate energy and less greedy for subsidies  but it still requires incentives.

Stimulating investment

With the near absence of national government support, supranational market mechanisms are key for stimulating investment into alternative energies. Carbon credits are already playing a role in cheapening financing for Latin American renewable fuel ¬projects, says Bruno Mejean, senior vice-president and deputy general manager at Nord LB in New York.

In the funding of the Benito Juarez hydro project in Mexico, Hanover-based Nord LB monetised future flows from anticipated carbon credits, worth about $630,000 a year through to 2012, to achieve additional debt funding of $2m. That enabled the project to squeeze through with just $8m in equity funding and enhanced the internal rate of return on some measures by about 5%.

The use of carbon credits is constrained, however, because of the uncertainties about what happens after the Kyoto Protocol expires in 2012, says Mr Mejean. The World Bank has devised contracts that last until 2015, but the value of carbon credits will be reduced over time after 2012 and become practically worthless after 2015, an issue that will need to be tackled globally.

Collaborative efforts

Given Latin Americas uncertain investment climate, the collaboration of a number of investors is often key to getting a project off the ground. Nord LB, which has worked on hydro v projects in Mexico and is working on geo-thermal projects in Costa Rica and Mexico, sees great interest from development banks. At the time of putting together the Guanacaste project [a Costa Rican wind project], every single one of the big development banks called us up, notes Mr Mejean.

There is a lack of private sector financing for this area with restrictions on terms and conditions, says the IDBs Mr Jackson, justifying the role of multilaterals. It is not just that the sector is new, but also many businesses in the region face difficulties in accessing loans. Chile and Panama are relatively well served with easier access to more loans than the world average, but the rest of Latin America lags behind the global mean and borrowers in Ecuador, Uruguay, Argentina, Bolivia and Nicaragua all face severe restrictions.

In the renewables sector, Mr Jackson regards the multilaterals role as enhancing what are essentially private sector investments. The official aim is to spend $300m in the region on renewable energy in the next five years, although he expects disbursements to be considerably more. The IDB is also encouraging work in many promising fields, including sustainable biofuels, as well as energy efficiency and projects in solar, wind, small scale hydro and waste.

National trade and export promoters are eager to join in. The USs Overseas Private Investment Corporation (OPIC) has recently started to focus heavily on renewables and is keen on small-scale projects, which banks often overlook. Lynn Tabernacki, senior manager, renewable energy and environmental finance at OPIC, says that because the cost of OPIC financing to sponsors is based on US Treasuries, now is as good a time as any to tap the institution. OPIC is offering loans at bargain basement prices of 3.75% plus fees with terms from three to 20 years, she says. The caveat is that there must be a minimum 25% US ownership in the project.

Where foreign support is not available, local development banks are closing the gap. In Brazil, where long-term funding is hard to come by, the national development bank continues to play a dominant role. That is particularly the case in local currency, where organisations such as OPIC are not able to operate, and where commercial banks face difficulties because of the unavailability of foreign exchange hedging contracts much beyond five years. Mexico, on the other hand, has 20-year financing from overseas commercial banks and so is less dependent on development bank financing.

Private investors

Whereas development banks are prepared to fund new technologies and small projects, private investor routes into renewable energy tend to focus on larger deals with safety features. Nevertheless, funding mechanisms are multiplying, says Cassio Schmitt, head of project finance at Santander global banking and markets.

In Brazil, for example, several funds have been raised to invest in clean energy, including Energias Renovaveis SA with $430m. Investments are found across mini hydro plants and biofuels, and are arriving in wind projects.

One of the perennial problems that is particularly severe for new energy types is that to secure debt funding, the technology needs to be tested and with a proven track record. That means that new generations of technology usually have an equity risk profile, says Daniel Mallo, managing director, project and energy finance at Société Générale.

Another common reason for banks refusal to grant lines of credit is that sponsors have not thought through how they will sell electricity. We see many plans that dont have well thought-through marketing plans. There needs to be a contractual framework, says Mr Mallo.

Business plans need to detail how the energy will be sold, agrees Alexandre Tilmant, head of private equity  energy and commodities at BNP Paribas. The French bank also places a strong emphasis on tight cost controls, he says. What equity financiers are looking for is strong ideas and management, with the CEO playing a particularly crucial role. The management should be able to prove that it can deliver capital gains to investors, says Mr Tilmant.

The scale hurdle

Another difficulty in a sector that has many small projects is the need for size and scale. Equity investors prefer large projects where there is liquidity and which can catch the eye of large investors, says Mr Tilmant. It is also key that there is sufficient capital and flexibility to get the project through to the first liquidity event so that the sponsors do not need to tap markets unexpectedly. Unanticipated fund-raising leaves companies prey to the possibility of weak markets and distracts management, he says.

The sense of optimism was not confined to the forums official sessions. On-the-sideline chats between investors and would-be project managers were rife. There are some interesting -private equity guys here with real money to spend on alternatives. It is better than it was in the past and thats got to be a good sign, said one sponsor adviser before being whisked away.